According to Newzoo, the worldwide gaming industry will reach $116 billion in 2017, up over 10% from the previous year. In addition, that number is set to grow at an 8.2% annual rate over the next few years, to over $143 billion by 2020.
As you may expect, many gaming-related companies have ridden that wave to tremendous gains; however, one gaming stock has gone in the opposite direction: GameStop (NYSE:GME). It has shed almost half its value over the past three years, trades at a bargain-bin valuation of just 4.6 times trailing earnings, and has a sky-high 9.5% dividend yield. So what's going on here?
Physical goes digital
The main fear surrounding GameStop is that digitally downloaded games will eventually replace the physical discs GameStop has traditionally sold. In addition, GameStop is a brick-and-mortar retailer, a sector that has been roiled by the increasingly digital economy.
GameStop has begun selling digital games, but digital revenue makes up only about 1.9% of its total revenue, and management has tacitly acknowledged that digital downloads represent a long-term threat. Between 2014 and 2016, GameStop's revenue from console sales declined 31.1%, and new game sales declined almost 20%. However, that trend looks like it will be broken this year -- the 2017 introduction of the Nintendo Switch, the first new system to come along in three years, turned GameStop's console and new game sales positive in the recent holiday period.
Management also doesn't believe physical games will be going away. In a recent conference, CFO Rob Lloyd explained that about 30% of games are downloaded digitally today, though certain select titles have launched at over 50% downloads. Even on these titles, Lloyd said, GameStop gets a large share of the remaining industry purchases. In addition, management believes there are barriers to full-on digital disruption, due to the amount of storage space digital games take up, as well as the time they take to download.
In addition, many gamers depend on physical trade-ins at GameStop, where they can receive as much as a 33% credit for new games, and GameStop believes there is a core group of gamers who depend on this trade-in credit to keep purchasing new titles.
Trying to diversify
Still, if digital disruption does begin to accelerate, GameStop has made a big effort to expand its non-game business segments, which now encompass roughly 40% to 45% of sales. The company has acquired its way into three new lines of business: collectibles; AT&T franchises; and Simply Mac stores, which are mini Apple stores in smaller communities that don't warrant an Apple-owned store.
The collectibles segment, which came to the company via its acquisition of ThinkGeek.com, has been a big positive, growing a robust 26.5% in the third quarter 2017. This business seems to hold a lot of promise, as it's synergistic with the core gaming business and taps into other parts of pop culture as well. To keep the momentum going, the company recently hired an executive from Walmart to help enter into more exclusive licensing deals with big Hollywood studios and drive more exclusive products.
But while the collectibles business has been positive, Technology Brands, which encompasses AT&T franchises, and Simply Mac have been a different story. Recently, AT&T changed the way it compensates franchisees, focusing more on driving bundles with DirectTV rather than new phones and upgrades. As the industry has gone toward a leased phone model, people are holding on to their phones longer once their phones are paid off. The combined effect caused the company to implement a $350 million to $400 million write-down this quarter, mostly attributed to this Technology Brands segment.
As if there weren't enough uncertainty, GameStop has a new CEO in Michael Mauler, the former president of the company's international segment, which encompasses 2,000 of the company's roughly 7,500 stores. Almost immediately after his selection as CEO, the company fired its COO and executive vice president of brand development in an abrupt management shakeup.
Should you buy?
Clearly, there is a tremendous amount of skepticism and uncertainty about GameStop's future. While this year should return the company to growth thanks to the introduction of Switch, it remains to be seen if that growth is sustainable, or if rapid technological advances will cause GameStop to go the way of Blockbuster.
At the same time, the stock clearly has a lot of bad news priced in, so if you feel like taking a gamble on a high-risk, high-reward stock, or have special insight into the gaming industry, a contrarian bet on GameStop could very well pay off.
Billy Duberstein owns shares of Apple and AT&T. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of GameStop and has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and short April 2018 $18 calls on GameStop. The Motley Fool has a disclosure policy.